Buying Stocks On Margin

The past few years may have been tumultuous ones for your investment portfolio, but stocks and other financial instruments have since recovered much of their value. At times like these, you may begin to ask yourself if there are ways to increase the return on your investment. Borrowing money to leverage your investments is one way to do this.  But is it a good idea?

Sources of Funds to Buy Stocks on Margin:

When you borrow money with the intent of plowing it into an investment, you’re said to be “increasing your leverage.” Just like using a “Lever” to lift a heavy object… financial leverage can use a small amount of cash to do the work of much more capital.  The following are some common sources of leverage.

• Home-equity loans- Since the stock and bond markets are inherently risky, it’s unlikely that you’ll be able to walk into a bank and request a loan to increase your leverage in those arenas. It is possible, however, to take out a Mortgage against the value of your house for virtually any purpose. Many risk-takers who spot a golden opportunity in the market use home-equity loans or lines of credit to leverge their investments.
• Margin accounts- As long as your brokerage account exceeds a minimum threshold, your broker will allow you to borrow a certan amount of money from them to increase your investing power. Margin accounts come with strings attached, like interest rates several points above prime and borrowing limits of 30 to 50 percent of the size of your portfolio.
• Short sales- This can be a quick, profitable way to increase your buying power, but it’s also quite risky. To short a stock, you borrow its shares from your brokerage firm and sell them at a set price. If the stock price falls, you can buy them back at the lower price and return them to your broker, pocketing the difference.
• Options- Options are contracts which allow you to put down a small amount of money and control a larger number of shares for a limited amount of time thus providing excellent leverage for the time that the option is valid.
• Leveraged Funds- Buying leveraged Mutual Funds or Exchange Traded Funds (ETFs). Some funds are intrinsically leveraged providing 2X or even 3X the movement of the underlying index.

Benefits of Investing Borrowed Funds

Using leverage to goose your returns in the Stock Market can seem like a smart move when your investments do well. It’s possible to double your money in weeks or months by shorting a distressed stock near the top of its plunge and buying it back near the bottom. If you’re more conservative with your money, you can still reap the rewards of leverage by using a margin account to buy 50 percent more of a stock that looks to be on the way up. When you’ve made a tidy profit, simply sell the borrowed shares and repay your broker.

Drawbacks of Buying Stocks On Margin

Where there is increased reward, there’s usually also increased risk. The most common mistake you can make as with leveraged Investing is to forget that leverage cuts both ways. Investors can make more when the value of their shares is increasing but they will also lose more when the market turns against them. If you sell a stock short before it increases in value it can leave you in serious debt to your broker. If you buy on margin, don’t forget you have to repay your broker for the borrowed shares or funds unless you want to lose 5 to 10 percent of your portfolio to interest charges each year. Remember, investment debt can be a trap, just like any other form of credit. Holding it for too long can seriously affect your credit score.

If you’re a savvy investor, borrowing money for your investment portfolio can leverage your returns and put you in a great financial position. It can also be devastating to your finances and overall credit situation if you make a bad call or borrow more than you can afford to lose. Make an informed risk-reward calulation based on your financial situation before deciding whether to take the big step of Buying Stocks On Margin.

Guest author Jeffery Hackett is a self proclaimed financial guru and freelance blogger writing on behalf of www.paydayloans.org.uk.